Betty;
Some more interesting reading on Reg. S....
Pirates' Play?
Offshore dealsters have found a new way to beat U.S. investors
.....by Jaye Scholl
Offshore dealsters are at it again, and it looks like they've been reaping tidy profits at
the expense of unsuspecting U.S. investors. In 3 deals Barron's has learned about,
offshore investors have been getting cheap shares of U.S. companies through special
convertible debenture offerings. As their charts show, the share prices of the
companies involved have a mysterious habit of dipping just before the debentures are
converted, giving the offshore buyers that much more of a bargain.
The convertible debentures involved are cousins to securities sold under Regulation S,
the controversial 1990 amendment to the federal securities laws that allows U.S.
companies to sell unregistered stock to foreigners, usually at big discounts to the
prevailing market price. After 40 days, foreign investors can sell these securities back
into American stock markets. The flood of new shares often results in much lower
stock prices, (Barron's, April 29).
If anything, the Reg S convertible debentures can hurt existing share-
holders even more than Reg S stock sales because of the greater
potential for massive dilution. Editek, a North Carolina company that
sells diagnostic kits to test on-site for drug abuse and for toxins in
agricultural products, actually ran out of shares during a convertible
debenture conversion in April. The process sent Editek's stock reeling, and the
company, with 18 million shares outstanding, was faced with having to issue a further
32 million shares.
Thanks to new SEC disclosure requirements that took effect in November 96,
shareholders can find out if a company has sold Reg S convertible
debentures. If it has, watch out, because, based on the evidence so far, a plummeting
stock price is likely to follow.
Offshore investors have been converting their debentures into common
stock at just the right moment: when the common's price is depressed.
A mere coincidence? Don't bet on it.
Reg S convertible debentures work the opposite way from your garden
variety convertibles. Most investors buy convertible bonds expecting to receive interest
payments while waiting for the stock price to appreciate. They convert after the stock
price has risen above the agreed-upon conversion price. But in Reg S convertible
debentures, the conversion price is typically set by taking the average price of the
stock over the five days leading up to the conversion date.
For a kicker, the company gives investors a further discount from that final conversion
price. Obviously, the lower the price of the stock, the better the deal for the
convertible debenture investors.
As their charts show, at Editek, Chantal, and Ponders Industries, steep dips occurred
in the days leading up to conversion, and trading volume soared as sellers unloaded the
stock.
Last January, Editek, which trades on the ASE under the symbol EDI, relied on Reg S
convertibles to raise $20 mil for its acquisition of Medtox, a St. Paul, Minn., company
that makes medical diagnostic kits. Editek's stock began a long descent in January,
falling from $3 a share to around 53 cents in April, the point at which the conversion
took place.
Too Many Shares
At that bargain-basement price, investors were able to convert their holdings into
millions more shares than the company was authorized to issue, and the company
stopped converting. Investors sued Editek for the additional shares. Editek's
management, at least one of whom had participated in a Reg S convertible debenture
deal at another company, resigned. New management says it intends to honor the
conversions to those investors whose trading records prove they weren't part of an
organized effort to drive down Editek's stock price in the days before the conversion.
Another player in the new Reg S convertible debenture game is Chantal
Pharmaceutical, a name familiar to Barron's readers (Jan. 8, 1996). This cosmetics
manufacturer claimed it had sold $10 million worth of an anti-aging cream from July
through September 1995. But investors reacted negatively when they learned that one
entity, Chantal's distributor, was virtually the company's only customer. Moreover, the
distributor had the right to sell his entire company - lock, stock and $10 million worth
of unsold Chantal inventory -back to Chantal, an exit strategy that made the sales data
highly questionable.
Chantal subsequently restated its financial results, revealing a substantial loss. The
stock, which had traded as high as 28 1/8 a share in Dec. 1995, fell in subsequent
months. It hit a new yearly low of 2 1/2 in August when its auditors resigned.
Now Chantal has disclosed in its most recent financial statements that it raised $5.2
million in a Reg S convertible debentures deal that took place Oct. 30. The terms
called for conversion of one-third of the debentures into common stock shares 45 days
later, on Dec. 14. The price set in October was to be the lesser of $3.91 a share or
80% of the average closing price in the five days immediately preceding the conversion
date.
Lo and behold, Chantal's stock sank to new lows in the days leading up to conversion,
averaging 1 7/8 a share between Dec. 9 and 13. With the 20% discount, the
December conversion appears to have resulted in an additional 1.1 mil shares
outstanding.
Another case in point is Ponder Industries, an oilfield-service company. It halted
conversion of its 8% Reg S convertible debentures in July. That's when its stock, which
had traded at $6 a share in April, slid to 1 1/2 - just before requests to convert came
pouring in.
A debenture holder sued Ponder in the U.S. District Court for the Western District of
New York for failing to honor the conversion agreement. Ponder has filed a
counterclaim in the same district court against the debenture holders. The suspicion is
that the purchasers of the convertible debentures shorted Ponder shares, expecting to
cover their shorts with cheap stock they received from the conversion. Ponder Chief
Executive Larry Armstrong says he received guarantees from the dealmaker involved
that Ponder's stock price would be protected from a bear raid. The guarantee fell
apart, he says, which is why Ponder halted the conversion.
So far, the SEC has not commented on Reg S convertible debenture deals. But, based
on a review of filings with the SEC, the incidence of these deals is on the rise. And, no
surprise, the companies relying on them aren't portraits of financial health.
Solv-Ex, for example, has a $13 million Reg S convertible debenture deal under way.
As Barron's readers may recall, federal authorities are reportedly investigating trading
in Solv-Ex stock to determine whether convicted stock swindlers Arnold Kimmes and
Thomas Quinn are involved. The Albuquerque company, which claims to have a
method of extracting oil and other minerals from oil sands in Canada, has denied
knowledge of an investigation.
Why were Reg S debentures invented? They appeal to offshore dealsters because they
can be converted into common stock quickly and that stock can be sold in the U.S.
market almost immediately.
This eliminates some of the risk associated with traditional Reg S common shares,
which must be held offshore for at least 40 days. Ironically, by forcing companies to
disclose traditional Reg S deals within 15 days, the SEC may have promoted the
increased use of these rapid-fire Reg S debentures. Close a door, they crawl through a
window.
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